Insights and opinions from an internationally recognized authority on investment performance measurement

Monday, August 2, 2010

Confused?

We occasionally ask folks what they think is the most confusing aspect of the GIPS(R) (Global Investment Performance Standards), which typically results in a variety of responses. To me, the most confusing term is "discretionary account." Recall that compliant firms must place all actual, fee-paying, discretionary accounts into at least one composite. But most firms read "discretionary" and immediately take this to mean legal discretion; that is, does the firm have the authority to trade on behalf of the client.

But this isn't what the term means...it's dealing with discretion from a GIPS perspective. That is, has the client placed any restriction or requirement on the manager such that the result will not represent the manager's style? If "yes," then it's non-discretionary.

I was at a new client last week and they were putting every account into composites, even though they clearly had some flexibility at hand. For example, they had a new client which imposed a restriction which would have caused roughly 10% of their model's typical holdings to be excluded from this client account, which would have resulted in returns which wouldn't represent the composite. They were planning to create a whole new composite just for this account. And while they aren't prohibited from doing this, why do it if you can simply flag the account "non-discretionary"?

Discretion is a great tool that's available to all GIPS-compliant firms, but it must be used in a proper manner. Their rules for discretion must be documented in writing. And general rules such as "an account is deemed non-discretionary if the CIO (chief investment officer) feels the account has restrictions that impedes his ability to invest" don't work: we need clear cut rules; rules that can be tested by an independent party.

If you'd like to share what you think is confusing about the standards, feel free!

Spaulding, David Spaulding

About David Spaulding

is an internationally recognized authority on investment performance measurement. He's the founder and Chief Executive Officer of The Spaulding Group, Inc. (www.SpauldingGrp.com), and founder and publisher of The Journal of Performance Measurement. He's the author, contributing author, and co-editor of several investment books. He's actively involved in the investment performance industry, serving on numerous committees and working groups.
Dave earned his BA in Mathematics from Temple University, his MS in Systems Management from the University of Southern California, an MBA in Finance from the University of Baltimore, and a doctorate in Finance and International Economics from Pace University.
For more information please visit www.spauldinggrp.com/the-company/david-spaulding.html

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